Accounting: The Language of Business - Vol. 2 (Intermediate: Part 47)

Elections are a good deal like marriages. There's no accounting for anyone's taste. Every time we see a bridegroom we wonder why she ever picked him, and it's the same with public officials.

Will Rogers

Statements of Net Income and Comprehensive Income (Part E)

by

Charles Lamson

Statement of Net Income Elements and Classifications

 We begin our in-depth discussion of the income statement with the statement of net income, first discussing the elements and then presenting the format of the statement of net income.

Statement of Net Income Elements

The statement of net income includes four primary elements: revenues, expenses, gains, and losses. We discuss these elements in Exhibit 5.3.

EXHIBIT 5.3 Statement of Net Income Elements

Statement of Net Income Classifications

Managers make several decisions regarding the presentation, format, and the elements to include on the income statement, such as:

• Aggregating and summarizing accounts into financial statement components or line items.

• Grouping, or classifying, the components.

• Providing subtotals and totals.

For example a company could have several accounts for salary and benefit expenses in its general ledger. Management may decide to aggregate salaries and benefits with selling and other expenses and summarize them in a line item on the income statement called, "selling, general, and administrative expenses. Firms aggregate and summarize expenses by either nature or function. The nature approach refers to classification by the source of the expense such as:

• payroll costs,

• cost of raw materials used, or

• depreciation expense.

The functional approach refers to classification by the use of the expense such as:

• cost of goods sold (Manufacturing or merchandising function),

• sales expenses (selling function),  or

•  administrative expenses (administrative function).

The choice between the presentation by nature or function depends on factors such as the industry and company experience. Management selects the presentation that is faithfully representative and most relevant. U.S. GAAP allows firms to group revenues and expenses either by the nature or functional approach. However, the SEC requires reporting by function. Companies using functional presentation must include specific disclosures in the financial statement notes about the nature of the expenses. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 176-177*

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